Catastrophe Excess Reinsurance

A catastrophe can generate thousands of claims at once, and an insurer whose customers are concentrated in one region may face a much larger combined loss than ordinary day-to-day claims suggest. Reinsurance allows it to transfer a defined slice of that risk to another insurer.

The cedent is the insurer that issues policies and buys reinsurance, while the reinsurer accepts part of the cedent's risk in exchange for premium under the reinsurance contract. The original policyholder normally deals with the cedent, not directly with its reinsurer.

Catastrophe excess coverage attaches after losses from a defined event cross a retention: if a contract attaches above $10 million and covers the next $20 million, the cedent bears the first $10 million of eligible losses and the layer covers eligible losses above it, up to the layer limit. The National Association of Insurance Commissioners describes catastrophe treaty reinsurance as indemnity, subject to a specified limit, for losses above a specified retention arising from a catastrophic event or series of events, which contradicts the idea that every such contract pays without a cap.

Event wording is crucial. A storm may have wind, rain and flood effects across several days, while a treaty may define how related claims are grouped, and an hours clause or geographic boundary can affect whether losses count as one occurrence and whether the layer is reached.

Reinsurers often sit in layers: a lower layer may cover a portion of loss after the cedent's retention, while a higher layer starts only when the lower layer is exhausted, which helps an insurer buy protection against losses it cannot comfortably retain. Some contracts allocate less than 100% of a layer to one reinsurer.

If the insurer cedes half of an eligible $1 million excess, that reinsurer's share is $500,000 before limits and adjustments. The cedent retains or separately places the other half, and a percentage cannot make the payout exceed the underlying excess.

A severe event can pass beyond all purchased limits: if a $20 million layer is exhausted, the cedent remains exposed to uncovered loss above the top, unless another layer applies. The insurer also faces deductibles, basis risk, credit risk and time before reimbursement.

Catastrophe excess is not the same as quota-share reinsurance, in which a stated fraction of covered premiums and losses is shared from the start, whereas an excess layer only responds when covered losses cross an attachment threshold, subject to its own terms. For analysis, ask for retention, limit, event definition, ceded share, exclusions, reinstatement terms and reinsurer strength.

An impressive-sounding reinsurance purchase is useful only to the extent it fits the actual concentration of insured risks.